BEFORE THE UTAH STATE TAX COMMISSION
Petitioner, : FINDINGS OF FACT,
v. : CONCLUSIONS OF LAW
: AND FINAL DECISION
AUDITING DIVISION OF THE :
UTAH STATE TAX COMMISSION, : Appeal No. 88-1644
STATEMENT OF CASE
This matter came before the Utah State Tax Commission for a formal hearing on XXXXX. James E. Harward, Hearing Officer, Joe B. Pacheco, Commissioner and G. Blaine Davis, Commissioner heard the matter for and in behalf of the Tax Commission.
Present and representing the Petitioner was XXXXX, Attorney at Law. Present and representing the Respondent was XXXXX, Assistant Attorney General.
The appeal represented the consolidation of two cases: XXXXX v. Auditinq Division of the Utah State Tax Commission, appeal No. 88-1500; and XXXXX v. Auditinq Division of the Utah State Tax Commission, appeal No. 88-1644. The identical nature of the issues involved in the two cases made the consolidation practical.
Based upon the evidence and testimony presented at the
hearing, the Tax Commission hereby makes its:
FINDINGS OF FACT
1. The tax in question is sales tax.
2. Pursuant to the audit of XXXXX for the period XXXXX through XXXXX, the Auditing Division assessed additional sales and use tax in the amount of $$$$$.
3. Pursuant to an audit of XXXXX for the period of XXXXX through XXXXX, the Auditing Division assessed additional sales and use tax in the amount of $$$$$.
4. Petitioners operate XXXXX stimulation and stabilization services encompassing these types of services:
5. XXXXX involves the placement of various XXXXX compositions, fluids, and slurry compositions, into various places in the well. The purpose of XXXXX is to stabilize the well and/or to separate zones within the well hole.
6. XXXXX involves the injection of XXXXX fluids that are created with various additives into a well bore to extend the well bore laterally into the formation.
7. XXXXX is an extension of XXXXX 0using hydrochloric acid in combination with other agents to improve the flow capacity of a well by dissolving deposits that may be plugging channels in the rock.
8. In XXXXX, a special grade of XXXXX Cement is used with any combination of 54 additives, the use of which is dependent upon the conditions of the well. The actual formula of the cement used for each well is recommended by Petitioner's representative.
9. Without the expertise of the employees of the Petitioner, the raw chemicals or cement are of little value to the well operators, and likewise the services are of little value to the well operators without the raw materials.
10. Because neither the materials nor the services are of much value to the customers without the other, it is not important to the customer how the price is allocated between the materials and the services. The customer does not buy one without the other. Therefore, if only the materials were taxable then XXXXX could reduce the taxes by simply reallocating the price from materials to services.
11. The customer is purchasing the final product in the hole where it has its only value to the customer. The final product has value to the customers of XXXXX only after the materials and services together have been provided to the customers.
12. Petitioner did not pay sales tax on materials it purchased. Petitioner charged sales tax to its customers on the materials and remitted that amount to the State Tax Commission. The Petitioner did not charge sales tax on the portion of its invoice price which it claims was the labor portion.
13. Concerning cementing services, XXXXX synthesizes materials and services to provide a finished product which stabilizes the pipe located in the well. Once poured, the cement cannot be removed. The cement permanently affixes the casing to the surrounding hole and becomes real property.
14. When XXXXX delivers the products to the well operators, XXXXX makes its recommendations regarding the precise formulas to be used and the method of placement in the well. However, the well operators make the decisions to accept or reject the recommendations of XXXXX. The contracts contain a specific provision which states: "work done by XXXXX shall be under the direction, supervision and control of the owner, operator, or his agent and XXXXX will perform the work as an independent contractor and not as an employee or agent of the owner or operator." Thus, it is the well operators (customers of XXXXX) that convert the materials (cement) acquired from XXXXX into real property.
15. The cementing services of XXXXX are similar to a ready mix concrete company that sells concrete to a building contractor and pumps it to the location where it is needed by the contractor. In that case, as well as this case, the delivered product is subject to sales tax on the total charge, including the sellers cost for materials, labor and profit. In the case of a ready mix company selling and pumping concrete to a building contractor, when the concrete is converted to real property it is converted by the building contractor and not by the ready mix company. In this case, when the cement is converted to real property it is converted by the XXXXX well owner and not by XXXXX.
16. In contrast to the XXXXX services are not operations in which the involved personal property becomes part of or attached to real property. In each of these services the personal property used in stimulation becomes part of the production of the well and is returned when XXXXX and other fluids are taken from the well. In these cases, XXXXX has sold the products to the final consumer, and sales tax should have been collected on that sale to the final consumer.
17. In XXXXX, XXXXX, through its holding company, XXXXX, and XXXXX, combined to form a partnership known as XXXXX. XXXXX contributed 72% of the new partnership's assets including the contribution of the motor vehicles in question. XXXXX contributed 28% of the assets. XXXXX received a 72% interest in the partnership, and XXXXX received a 28% interest in the partnership.
Based upon the foregoing Findings of Fact, the Tax Commission now makes and enters its:
CONCLUSIONS OF LAW
1. There is a tax levied on the purchaser for the amount paid for retail sales of tangible personal property made within the state. (Utah Code Ann. §59-12-103)
2. Sales of tangible personal property to real property contractors and repairmen of real property are subject to sales tax.
3. Sales of vehicles required to be titled or registered within the laws of this state are not exempt from sales taxes as isolated or occasional sales, except that any transfer of a vehicle in a business reorganization where the ownership of the transferee organization is substantially the same as the ownership of the transferrer organization shall be considered an isolated or occasional sale. (Utah State Tax Commission Administrative Rule R845-19-38S(c).)
4. Two business entities Transferring assets to form and organize a new legal entity does not constitute a business reorganization. Instead, the two original entities have formed a new and separate entity.
5. XXXXX is not a real property contractor within the meaning of R86 5-19-58S. Instead, the portion of its product which XXXXX has labeled as services is really charges "for fabrication or installation which is part of the process of creating a finished article of tangible personal property" (the cement which is sold to the well operators) pursuant toR865-19S-51.
In both cases there are essentially two issues to be decided:
1. Is sales and use tax imposed on all of the charges made by XXXXX and XXXXX, or only on the portion of the charges which they have allocated to materials?
2. Is the transfer of motor vehicles to XXXXX from XXXXX exempt from sales and use tax?
IS THE SALES AND USE TAX IMPOSED ON THE TOTAL INVOICE PRICE FROM XXXXX TO ITS CUSTOMERS, OR ONLY ON THE AMOUNT WHICH XXXXX HAS
DESIGNATED AS THE PORTION ALLOCABLE TO MATERIALS?
In support of its position that the services are not subject to sales or use tax, the Petitioner advances two alternative theories:
1. The services are not incidental to the sale of tangible personal property. Rather, services rendered are part of a comprehensive service and the sale of concrete or other well stimulation materials are incidental to that comprehensive service;
2. The Petitioner is a real property contractor and is exempt from sales and use taxes, except for sales tax on the products which it purchases.
With respect to the Petitioner's argument that the services are not incidental to the sale of the materials used to case the wells and materials used in stimulating the wells, the Tax Commission finds the argument is not well taken.
While it is accepted that without the expertise provided by the Petitioner the materials are virtually worthless for their intended purpose, it is also accepted, as the Respondent in its brief states that "All of Petitioner's 'services' without the actual materials would be worthless to its customers. Likewise the materials without the services to blend them into the correct product and deliver it into the property would likewise be of for (sic) less value. It is the synthesis of these two things that comprise the product, the tangible personal property and associated services that Petitioner transfers to its customers. It is this synthesis of material and services that is subject to sales tax" (brief of Respondent page 7).
Where the Petitioner is in the business of XXXXX stimulation, the Petitioner operates as a retailer of tangible personal property. The services that it provides to its customers in the sale of these products is a necessary component of the final product and is taxable.
This rationale is consistent with the decision of the Utah Supreme Court in McKendrick v. State Tax Commission, 9 Utah 2nd 418, 347 P2d 177, (1959). There, the plaintiff, a manufacturer of artificial limbs, claimed the sale of artificial limbs were exempt from sales tax. The Petitioner alleged that what he was selling was a professional service in the making and fitting of the prosthetic devices and the materials used were such a small portion of the total charge that they were "merely incidental" to the service performed. The Utah Supreme Court disagreed with the Petitioner and stated:
It is quite generally true that
"materials", considered separate and apart
from "services", are not worth much.
The value of raw materials depends
upon their abundance or scarcity. These
are usually very small
in comparison to the products into which they are fashioned. Its the taking of ore from the mine or the
tree from the forest and then
making them into something useful which makes the end product desirable and therefore
During the process of transformation through various stages, the value is steadily enhanced in proportion to the expense of time, energy and skill thereon. An excellent example is the process by which a pound of iron ore, worth but a few cents, is mined, smelted, processed, tempered and fabricated into hair springs for watches worth thousands of dollars per pound. When one is sold its value is that of the finished product and not of the basic materials from which it was made. The same principle applies to the Petitioner's profits. Id. at 419.
With regard to the Petitioner's second argument that it is a real property contractor, the Tax Commission similarly finds such argument to be without merit. If the Petitioner were a real property contractor the sale to them of the materials in question would be subject to sales tax, and sales tax would be paid by the Petitioner and not by its customers. That, however, is not how the Petitioner conducted business. Here, the practice of Petitioner was to not pay sales tax on materials purchased by them but rather, charge its customers sales tax and remit the taxes to the Tax Commission. Those actions were not those of a real property contractor but were those of a retail sales business which purchased the materials for later resale.
It appears that the Petitioner would now ask that its own past actions which showed that it did not consider itself to be a real property contractor be disregarded simply because it is in its financial interest to do so. This the Tax Commission is not willing to do and finds such practice to be probative as to the true nature of the Petitioner's operation.
IS THE TRANSFER OF MOTOR VEHICLES TO XXXXX FROM XXXXX EXEMPT FROM SALES AND USE TAX
Under Utah State Tax Commission Rule R855-19-38S, sales of motor vehicles are not exempt as isolated or occasional sales except "that any transfer of the vehicle in a business reorganization where the ownership of the transferee organization is substantially the same as the ownership of the transferrer organization shall be considered as an isolated or occasional sale".
In the present case, XXXXX was created specifically to hold the assets of XXXXX and become a partner with XXXXX in the formation of the partnership known as XXXXX. XXXXX contributed 72% of the assets of the new company including the motor vehicles in question. XXXXX contributed the remaining 28% of the assets.
Under the facts as set out above, it cannot be said that the ownership of the transferee organization (XXXXX) is substantially the same as the ownership of the transferrer organization (XXXXX). Therefore, the Petitioners have failed to meet the requirements of Rule R865-12S-38 with respect to the transfer of vehicles.
With regard to both issues, the Petitioner claims that the findings of the Auditing Division were contrary to established policies of the Tax Commission. Petitioner argued that the Tax Commission could not reverse such a policy without complying with the appropriate administrative rule making statutes.
In support of this, the Petitioner offered the testimony of a single witness, a former employee of the Tax Commission, who testified that in his opinion certain policies regarding the two issues existed.
The Tax Commission finds that the opinion testimony of the Petitioner's witness was insufficient to establish that such policy did indeed exist. More importantly, however, there was no evidence presented which showed that even if such policies were in effect, the Petitioner relied upon them to its detriment.
Based upon the foregoing, the Tax Commission finds that the Petitioners failed to establish by a preponderance of evidence that its XXXXX stimulation services are exempt from sales and use tax. The Tax Commission also finds that the Petitioner has failed to establish by a preponderance of the evidence that the transfer of motor vehicles from XXXXX to XXXXX were exempt from sales and use taxes. The findings of the Auditing Division are therefore affirmed. The request of the Petitioner is denied. It is so ordered.
DATED this 2 day of July, 1990.
BY ORDER OF THE UTAH STATE TAX COMMISSION
R. H. Hansen Roger O. Tew
Joe B. Pacheco G. Blaine Davis